Interest rates could fall below 2pc: Gregory

Bob Gregory, left, and Ross Garnaut, right, said the impending end of the resources investment boom and the decline in resource prices would dominate the landscape for whichever party won the next election.
Photo: Angus Mordant

Former Reserve Bank of Australia board member Bob Gregory and China expert
Ross Garnaut
have ­predicted that interest rates will fall steeply but added that would not prevent a sharp slowing in economic growth and a decline in living standards in coming years.

The two prominent economists, delivering the keynote addresses at the Australian Agricultural and Resource Economics conference in Sydney on Wednesday, said the impending end of the resources investment boom and lower resource prices would dominate for whichever party won the election.

Professor Gregory, a labour market economist, said interest rates could fall as low as 1.5 per cent because the RBA would try to stimulate to compensate for the end of the resources investment boom, and he expected a substantial decline in the prices of raw materials.

“Interest rates will fall. But I don’t think it’s going to work that much," said Professor Gregory, who in the 1970s diagnosed the phenomenon of so-called Dutch disease, where a mining boom drives up exchange rates and hurts the rest of the economy. The RBA left rates on hold on Tuesday.

Professor Gregory predicted Australia’s real income could fall by 15 per cent in the next few years and whatever side was in government would have to convince people to accept lower living standards.

“The investment boom is going to peak and I can’t see something filling the hole quickly," he said.

Even if the exchange rate fell and Australia became more competitive, it would take some time for sectors such as manufacturing, home construction and tourism to pick up the slack. In an optimistic scenario, unemployment would still rise to 6 per cent.

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Professor Gregory said governments should be investing in infrastructure to ease the transition but this was politically impossible because of the focus on returning to surplus.

Professor Garnaut, author of the federal government’s climate change review and a former ambassador to China, said the government and the RBA had been “complacent about the challenge of managing fluctuations in the terms of trade". The RBA had been too slow to cut interest rates, which was hampering the economy now that the resources investment boom was slowing and prices, especially for thermal coal, were falling sharplys, he said.

There had been a “bloodbath" in the price of thermal coal stocks, reflecting lower Chinese demand. This would continue because the Chinese last week announced more measures to cut coal consumption.

“We are now seeing the downturn. We are going to need much bigger contributions from the non-resource tradeable-goods industries," he said.

The RBA should cut rates to try to lower the dollar and boost those industries. “To have our short-term interest rates 2 or 3 percentage points higher than other developed countries gets in the way of the exchange-rate adjustment that we will need to make and which will be a more painful adjustment the longer it is delayed."

He said Australia faced a period of falling real incomes and it remained to be seen whether this would involve a serious recession, as in the 1990s.